Eastern European Economies Revving their Motors

Six top German economics institutes recently published their forecasts for economic growth in the twelve-country eurozone; the numbers weren't good. They predicted the countries that adopted the common European currency -- Western Europe and Greece -- would only grow by some 1.5 percent in 2004.

It's the kind of sclerotic growth that the new upstart EU countries further east can only shake their heads at in sad wonder. After years of communism, where profit was taboo, and the freefalls of the early 1990s, when the region's new capitalism shook out the dust from the planned economy past, Eastern Europe's growth has reached levels that are turning their western neighbors green with envy.

In fact, over the past few years, economic growth in countries in central and eastern Europe has outpaced global economies on the whole.

Poland's economy has taken off, growing by 3.7 percent in 2003, compared to 1.4 percent a year earlier. Hungary's gross domestic product (GDP) grew by 2.9 percent in 2003 -- a poor showing for this central European state -- but is expected to expand by 3.5 percent this year. The Slovenian government has forecast 3.6 percent GDP growth in 2004 and 3.7 percent growth in 2005.

"New (EU) members have much stronger growth, and while there is certainly a catch-up effect involved, it is also because we enacted structural reforms," Slovak Finance Minister Ivan Miklos recently told the wire service Agence France Presse.

Business-friendly reforms

Those reforms include slashing corporate tax rates, deregulating labor markets and largely privatizing their economies. While some Western EU nations, such as Germany, try to push through similar reforms to jump start their ailing economies, they have faced massive protests from unions, interest groups and citizens who are angry about cuts in social welfare programs and the easing of labor market rules.

In Eastern Europe, it's not a problem.

"Here you have a region where regulations are kept to a minimum and where unions do not really have much say," said Hana Machkova, a professor at Prague's school of economics.

The Baltic state of Estonia chose to adopt the recommendations of American liberal economists by completely abolishing its customs duties and agricultural subsidies and instituting a flat tax. Poland and Slovakia have simplified their tax systems to the extreme, slapping a 19 percent rate on sales, income and business taxes. Hungary set its tax rate at 16 percent.

In the current EU member states, the EU-15, the average rate is 31 to 32 percent, according to a recent study by the auditing group KPMG.

The low tax rates and still relatively cheap labor have proven to be a siren song for companies around the globe, but especially western Europe, who are moving production facilities out of countries with higher wage costs to this eastern economic Shangri-la.

In Germany, engineering giant Siemens could shift up to 10,000 jobs to eastern Europe in the coming years. It has announced it will move 2,000 telephone production jobs to Hungary where labor costs are lower. Volkswagen already produces 13 percent of its vehicles in central and Eastern Europe and air carrier Lufthansa will move most of its accounting and purchasing operations to Poland.

The bandwagon heading in the dawn's direction looks like it will soon be very full. But the roads carrying foreign investment east have already been well trod. According to Merrill Lynch, eight former communist new entrants attracted $126 billion (€107 billion) in investment between 1993 and 2002, almost six times more per capita than China.

Rosy picture, but challenges lie ahead

The news is mostly good for eastern Europe's economic aspects, but that does not mean there aren't serious problems the region will have to tackle. One of the major ones is joblessness.

Fifteen years after communism, the official unemployment rate in eastern Europe is still high, averaging 14.3 percent in the accession countries and as high as 19.2 percent in Poland.

Average incomes are still under half the average of those in the EU-15. Only Slovenia comes close to the income levels of the union's poorest member, Greece. High fiscal deficits are still at risky levels in the accession countries and corruption, while less of a problem than it was a few years ago, is still a cause for concern among investors.

Many countries also face troubling infrastructure problems, particularly in rural areas. It's in the rural areas where the region will have to focus its energies if it does not want bigger problems later on. Many of the new EU states suffer from wide gaps between successful urban elites and poorer people in rural areas, who are often old, poorly educated and unemployed.